The Vacation Home LLC

Sep 3, 2015

A family vacation property is its own type of unique asset, and as such, it deserves its own structure for decision-making, succession, and managing transitions within a family. A well-conceived governance structure for a vacation property involves many practical issues. For example:

  1. What kind of structure is the best? Trust, tenants in common, corporation, limited liability company?
  2. How will the decision-making be allocated among family members – a small group of family members or each member has some active role?
  3. Who can use the property, who pays the upkeep and other operational expenses, and how will those funds be collected, managed, etc.?

In essence, aside from the purely personal use nature of the asset, the family vacation home has a lot of similarities with that of managing a family business. (For this article, I am assuming the property is NOT held out for rental to any third party or non-family member.)

A common example is as follows: Parents presently own property in the North Carolina mountains (the beach is also a common location) and acquired the property many years ago. (The same issues are generally present where the property is not yet owned and parents are looking for a family vacation place.) Parents and their three children have been using the property as vacation property and family retreat (and for family reunions) for many years. The property has not been rented, thus all expenses to date have been paid by the parents. The parents want to continue to use the property and have complete management authority until relinquished due to death, incapacity or voluntarily by transfer, and they are interested in transferring ownership and other responsibilities to the children currently so as to be able to provide “guidance.”

Among the various alternatives for owning the limited liability company (“LLC”) is the preferred vehicle for tax efficiency and management flexibility. North Carolina, like many other states permit LLC formation for any lawful purpose; therefore, LLCs can be formed for non-business purposes. Thee LLC allows families to establish a system for managing and controlling the property, restricting the transferability of ownership interests, preventing and resolving disputes among family members, and providing estate planning and gifting options that do not involve real estate transfers that would otherwise be required if the property is held by the family members as tenants in common.

LLCs can also provide liability protection to its members and managers. However, there are several exceptions that depending on the facts may apply to weaken such protection.

In addition to liability protection for members as to activities on the LLC property, members and the LLC enjoy a level of protection as to claims of creditors of other members. In the case of a LLC, a member’s creditors can generally obtain a charging order on the member’s economic interest. However, the charging order effects economic rights only and does not afford the creditor any other rights regarding the LLC’s property.

LLCs also offer flexibility in transferring ownership to other family members. Membership interests in LLCs are the members’ personal property and transfers of membership interests do not involve conveyance of real property owned by the LLC, which remains LLC property. Therefore, use of a LLC allows intra-family transfers without triggering anti-transfer contractual provisions imposed by lenders (other than those specifically drafted to include transfers of underlying membership interests), without causing real property transfer fees and taxes, and without affecting an owner’s title insurance policies and rights.

The “family” vacation home is intended to be just that – for family. Thus, the goal is to limit ownership to only family members and the objective is to restrict the ability of family members to transfer their interests to outsiders. Membership interests in LLCs are personal property and generally reasonable restrictions on transfers are enforceable.

LLCs contemplate that all members enter into an operating agreement that sets forth management rights and powers in considerable detail. Management authority and managerial roles can be defined in the operating agreement, and power can be given to different generations when desired. Also, operating agreements can be binding on transferee members and successor managers who did not execute the agreement when the LLC was established.

A detailed outline of an operating agreement is beyond the scope of the article, however, the following are some of the key provisions that should be included:

  1. Who Can Use the Property. Members only or members and other specific group of permitted users?
  2. Costs. How are costs allocated among member and other permitted users?
  3. Right of First Refusal. The operating agreement can contain a provision giving the members a right of first refusal to acquire any portion of the LLC’s property that is to be sold.
  4. Membership. Membership should be limited to the original members and their lineal descendants by birth or adoption, or trusts for their benefit. Whether spouses will be added is purely a personal decision.
  5. Management. Management is vested initially with the parents, and may transition to the other members (i.e., children over time).
  6. Transfers of Interests. To whom? With or without other members’ consents?
  7. Options to Buy. The operating agreement can contain provisions that permit the other members to buy the interest of a member that is going through a divorce, bankruptcy, or another attempt to transfer the interest outside the family. This helps ensure that interests in the LLC are not held by unwanted owners. The buy-out can be all cash or part cash and financed via a promissory note.

As is evident form the above discussion, a carefully planned operating agreement that takes into account the family’s unique dynamics and that allows a flexible management where generations can be introduced to owning and operating what will hopefully become theirs in the future is critical. It is also crucial that the parents and the children have frank and open discussions as to how all envision the use and ownership of the property, and that the family adopt some form of “mission statement” to be incorporated into the operating agreement.

I would like to thank the insights provided by the law review article by J. William Caulson entitled “Nine Bean Rows, LLC – The Limited Liability Company to Hold Vacation Homes & Other Personal Use Property,” William Mitchell Law Review, Vol. 38:2, page 592; and the article by David Burleigh entitled “Vacation Homes – Succession Planning Can Be Serious Business,” WG&L Estate Planning Journal, April 2015.

 

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